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Why Free Cash Flow Matters and What To Do With It

Achieving financial independence isn’t about having enough money in the bank to last you through retirement. Unfortunately that’s how most people think about money. We work so that one day we’ll have enough money in our nest egg to get us through our remaining years. This thinking often leads to many more years worked than necessary because we all fear running out of money.

The real goal for anyone trying to achieve financial independence is to achieve an equilibrium between money coming in and money coming out. Ultimately we want to ensure a steady stream of income even when we’re not working. That’s truly what financial independence really means.

But how do we achieve that? How do we get there? First off you need to understand cash flow. Regardless of what anyone tells you, cash flow is king. Any well run business generates positive cash flow. The simplest form to understand is that we want more money coming in than going out. Personal finances are no different. You want to keep your cash flow positive on a month to month basis.

How To Create Positive Cash Flow

There are a few ways to achieve positive cash flow. Some are easier than others. The quickest and simplest way is to reduce spending. No matter how much it hurts, reduce eating out, watch movies at home instead of theaters or refrain from buying the latest smartphone. Reducing spending is the easiest way to increase cash flow, but probably hurts happiness the most.

It’s surprising to me how the little things can add up over time too. Find savings by looking at bad habits. Some of it could be making sure you don’t pay bank fees. Stop using ATMs from third party sources or other banks. Stop buying clothes you wear once and ultimately ends up at the bottom of the closet. Got 24 pairs of jeans? Stop buying them.

We live in a world of consumerism. It’s quite easy to get carried away with buying things that we don’t need. When we buy things it gives us instant gratification, but the result of too many unnecessary purchases is what puts us in difficult financial situations.

A second way to increase your cash flow is to increase your income. That could mean asking for a raise from your current employer. You’d be surprised how much we underestimate our value and the work that we do. If you feel you deserve a raise, justify it. Ask for it.

You can also get more money by doing gigs on the side. Work weekends or do some part-time work to get extra cash. People might think that an extra $100 dollars made on the weekend is nothing, but over time it adds up.

From time to time it’s also good to explore other employment options that may be available. That’s a good way to gauge what your worth is out in the open job market. It’s hard to determine what the going market rate is for your position and it’s highly unlikely for your colleagues to be singing their salary in the office. If there are better opportunities for career advancement that offers better compensation, then it might be worthwhile to make the jump to another workplace.

All of these ways can be used to increase cash flow. They all require some form of work or commitment to make happen, whereas decreasing spending is by far the easiest and quickest path to take.

Cash Flow Creates Freedom

How many times have you heard friends and family complaining that they don’t have enough money and they are living paycheck to paycheck? Yet they have good jobs? That’s actually not as uncommon as you may think. Individuals making decent salaries but living in expensive cities like Toronto and Vancouver tend to stretch their paychecks to the limit. That’s all because o the lifestyle choices we decide to make. Many want to own their homes. That’s fine, but the consequences of that choice is greatly reduced cash flow. That cash flow is the difference of feeling stressed over money or not.

Lowering living costs by renting can have it’s advantages of providing extra cash flow to use at your disposal on a month to month basis. That means that free cash flow can be used for other purposes like taking a vacation or using it for investments. That flexibility and freedom is something you can’t get if your monthly paycheck is going towards food and mortgage payments.

Cash flow gives the freedom of choice. Imagine if you have an extra $2,000 a month to spend versus someone with a mortgage that may only have $700. The person with the excess cash flow can choose to take a vacation almost immediately. The following month she can choose to save the extra $2,000 rather than spend it because last month’s excess was used. Someone having $700 of extra cash will have to wait at least 3 months before she has enough saved up enough for the same vacation. In order to replenish the money spent she would have to save another 3 months. That’s 6 months to achieve the same savings rate, where someone with excess cash flow can recover within just one month.

This type of greater flexibility is a lifestyle choice. Someone who chooses to live this way can still save just like a home owner. She can choose to invest her money instead on a balanced investment portfolio rather than owning a single asset. She may choose to use the money to further her education without having to take a loan out against a home. Having excess cash flow leads to a greater freedom of choice. Choice that one wouldn’t have living paycheck to paycheck.

Make It Work For You

If there is anything that is most rewarding about having excess cash flow, it’s that it allows you to have the freedom to deploy your assets to work for you. If you are unable to have excess savings after expenditures, it’s extremely difficult to build up an investment portfolio that will work for you later on in life.

Most people find it disheartening to have so little saved, but it does take perseverance and dedication to devote your savings into a long term investment plan. It’s always so tempting to use our excess cash flow on luxury items that are gratifying, but putting away just a little bit over the long haul of 10 or more years will see that patience and perseverance pay off. Literally.

Remember, like The Wealthy Barber says, save 10% of your pay for retirement. That’s the magic number. Try to achieve that 10% excess cash flow and put it a way for good. Invest it and by the time retirement comes around you’d be surprised what compound interest can do for you. We’ll explore later why the savings rate is more important than income in a later post.